Old Dominion Freight Line, Inc. - Q2 2024
Transcript Notes
Old Dominion Freight Line, Inc. - July 24, 2024
New Capacity Investments
Continued capacity investment allowing ODFL to take advantage of a future capacity constrained industry. Currently operating with 30% excess service centre network capacity.
This creates short-term cost headwinds, but allows for very profitable future growth as the demand LTL services grows over time.
We have been one of the only LTL carriers to constantly and consistently invest in new capacity over the past 10 years, which has supported our ability to almost double our market share over the same period.
We are committed to constantly investing ahead of our anticipated growth curve, which is another differentiating quality for old dominion and what has been and what we believe will continue to be a capacity constrained industry. Over the past 10 years, we have invested over $2 billion in our service center network and we plan to invest another $350 million on real estate this year. These investments have positioned us to grow with our customers over time through the ups and downs of the economic cycle, which hasn't been the case with most of our competitors.
Maintaining excess capacity in our service center network, which is approximately 30% at the end of the second quarter, does create some short-term cost headwinds during periods with slower demand, but we are confident that the capacity will be critical to support our customers when the economic environment starts to improve and business levels reaccelerate. With all that said, our network investments are not being made simply to handle the overflow during stronger periods of economic activity. Instead, as we look into the future, we believe demand for service sensitive LTL capacity will continue to grow.
Operating Ratio Ingredients
Operating ratio improved 40 basis points mainly due to managing direct variable costs and organic revenue growth of roughly 6%.
Domestic economy is still seeing slowness, long-term operating ratio does depend on overall economic health to some extent.
Revenue expected to be up 3.5% from Q2 to Q3 based on historic seasonality.
55-60% of revenue is currently industrial related.
Look for increases or decreases in weight per shipments.
Our operating ratio improved 40 basis points to 71.9% for the second quarter of 2024 due primarily to the quality of our revenue growth and continued focus on operating efficiencies. Our team continued to do a great job of managing our direct variable costs during the second quarter, which allowed us to improve these costs as a percent of revenue.
Our overhead costs, however, continued to increase as a percent of revenue despite our best efforts to minimize discretionary spending. As we have often said before, the two main ingredients to long-term operating ratio improvement are the combination of density and yield, both of which generally require a favorable macroeconomic environment.
While we continue to execute on our yield management initiatives, it will likely take an improvement in the domestic economy before we see sustained momentum in shipping demand that generally leads to incremental market share opportunities and operating density. We remain confident that once we have both of these elements working again in our favour, our team can produce further improvement in our operating ratio and make progress towards our goal of achieving a sub-70 annual OR.
Based on kind of where we are today, normal seasonality is typically about a 50 basis point increase sequentially from the second to the third quarter, and I think that's achievable. It's certainly what the goal would be, and I think that regardless of which way the revenue goes, if we stay kind of flattish like we've seen from a quarter-to-quarter standpoint, typically the average sequential change in revenue is about a 3.5% increase from the second to the third quarter.
Unfortunately, we're still dealing with an economy that's not contributing too much to us right now with 55% to 60% of our revenue being industrial related. The ISM continues to be below 50, and I think that's 19 out of the past 20 months.
From an operating ratio standpoint, the fourth quarter is typically about 200 to 250 basis points higher than the third. And a lot of that is the revenue level softening a little bit. We've got three months of that wage increase. And that normal change, if you remember from last year, we always have actuarial assessment of our insurance reserves in the fourth quarter and those adjustments can go one way or the other and I generally view those as a reconciling item to whatever that normal change is. And last year was an unfavorable adjustment to that insurance and claims line. A few years prior they had been favorable adjustments. So kind of throw that out of the window when just looking at what is that normal cost progression change.
Reduced Share Count Continues
$551.8 million used on repurchasing shares in Q2, 2024.
Q2 was a great time to add shares of ODFL (I lucked out with timing here).
Old Dominion's cash flow from operations totaled $387.8 million and $811.7 million for the second quarter and first half of 2024, respectively, while capital expenditures were $238.1 million and $357.6 million for those same periods. We utilized $551.8 million and $637.1 million of cash for our share repurchase program during the second quarter and first half of 2024, respectively, while cash dividends totaled $56.0 million and $112.6 million for the same periods.
This year-to-date total for share repurchases includes $40 million that is deferred until the final settlement occurs on our current accelerated share repurchase agreement, which would be no later than November of 2024. Our effective tax rate for the second quarter of 2024 was 24.5%, which was lower than originally expected due to the benefit of certain discrete tax items. The effective tax rate for the second quarter 2023 was 25.4%. We currently anticipate our effective tax rate to be 25.0% for the third quarter.
No, it's no change in capital allocation. I think it's similar. It was a record level, as you say, but you go back a couple of years ago and when our stock performed similar to the big drop that we saw during the second quarter, if you go back to 2022, we spent $1.3 billion in total that year, so had some pretty hefty quarters that was just spread more through the year. But our stock was off 20% to 25% from 52-week highs going back to the last quarter's phone call and earnings call and so as we've done in the past, we stepped in and were more aggressive with our repurchases.
Now the stock price has recovered a bit and so be going back more so to kind of our normalized grid based approach to repurchasing shares. But we just stepped in a little bit more aggressively with the cash that we had on the balance sheet and purchased more during that second quarter, including an accelerated share repurchase agreement as well, and which we still got a little bit of about $40 million that was deferred on that agreement, that should settle sometime late third quarter or early in the fourth quarter.
Inflation Based Price Increases Continue
Management philosophy on pricing not compared to competitors, but compared to real costs will continue.
I think what we've seen is just a continuation of executing on our long-term yield management philosophy, and we continue to target increases that offset our cost inflation and support the continued investment in capacity and technologies that our customers expect from us. And our yield trend in June and what we're seeing thus far in July is pretty similar from a year-over-year standpoint.
If you just sort of look at normal seasonality and revenue per hundredweight, at least excluding fuel, normal sequential would imply that for the full quarter it would be up 4% to 4.5%, that metric, and some of that will be some mix change that we'll go through more so in August and September. If you think last year, following the disruption to the industry, our weight for shipment decreased quite a bit as we moved through August and September last year. Overall for the third quarter of 2023, it was down about 30 pounds versus the second quarter of 2023.
I think that we're going to go with the 50 basis points being the target for increased tonnage as part of the 4-4.5% increase in revenue per hundredweight. And again, keep in mind, just like we said last quarter, it's put a plus or minus around that. I am not being that specific, anything can happen. But I think that our team is continuing to do a great job with managing cost in this lower volume environment, and we will continue to do so as we progress through the third quarter. And so obviously it's a little bit easier if we've got some revenue contribution, we typically have an increase in certain cost elements as we progress through the quarter.
We're continuing to execute on our CapEx plan. So we will have incremental depreciation dollars in the third quarter versus the second. We have a wage increase that will go out the 1st of September as well as it always does, so you get one month of that. And so we'll continue to monitor and measure operating efficiencies and we've been seeing some improvements there and have some other offsets as well. Continue to manage every discretionary dollar that's going out the door in managing to the business levels that we're seeing.
Weight per Shipment Trends
Weight per shipment trends will be the trigger to watch for improved operating efficiencies.
No real change in July, still kind of continuing to bounce around that 1500 pounds mark. And to me I think that's what we've seen. Obviously we saw the unique change that happened last year right at the end of July going into August. And that took our weight down quite a bit like I just mentioned.
But it just feels like we've been bouncing along the bottom and I think that's an indicator really where the industrial economy has been as well. So I think that should be one of the first signs and early indicators. If we start seeing some incremental weight on each shipment that we're picking up, that orders might be picking up and that would obviously be good for a lot of measurements.
If we can get more weight per shipment, generally that's going to lead to the improvement in operating efficiencies and generally that leads into improved volumes in general if the underlying economy truly is improving. So all things that we are very prepared for in terms of the capacity in our service center network, the capacity of our people and our fleet, we are primed and in position to respond whenever the market does. In fact inflect to the positive.
Excess Capacity of Peers
Yellow Corp bankruptcy is clearly a long-term benefit to ODFL. 10% of capacity was taken out of the market, which ODFL can continue to pick up “for free” because they have been investing ahead of their growth curve.
We estimate that shipping volumes are down about 15% from the peak back in 2021. And when you look at the number of service centers that have settled from that bankruptcy proceeding, not all are in operation yet, but probably at least 10% and maybe more capacity will be coming out of the market.
So, all those shipments that were being picked up and delivered by that carrier they are LTL shipments. They will come back to the market and our market will recover to the levels where it was previously and I believe will continue to increase further. So that's why we continue to believe and continue to invest ahead of our anticipated growth curve. We don't see anything that has changed with the opportunities that we have for long-term market share opportunities other than perhaps maybe they've gotten stronger.
As more shippers look for high quality service carriers, inventory management continues to be an operating focus, especially in a higher interest rate environment, I think it puts the burden on shippers to select high quality carriers and there's none better than old Dominion. So we look at the market generally and believe we've got as strong an opportunity that we've ever had and we think we're better positioned than any other carrier to capitalize on and improve in the industry.
Revenue Seasonality
Trends look normal, July and October are the slow months from a month-over-month revenue growth perspective while September is the strongest month.
ODFL found a way to grow revenue by 6% organically in an unfavourable environment, things will get easier for them as economy improves over time.
Note to self: ODFL Analysts are obsessed with short-term trends, look to take advantage of this if the market presents an opportunity.
From a pure revenue standpoint, though, and just looking at revenue per day, July and October are the months that we see decreases in as we go month-to-month and progress through the year. And what we're seeing from a pure revenue per day standpoint is it's pretty consistent with what normal seasonality would otherwise be, which is a drop off somewhere in kind of the 2.5% type of range and that's pretty consistent with what our five year average has been there.
So we'll look to see that we get some recovery back in August, which is normal and then September, as you know, is pretty much our strongest month of the year. So can we see stronger acceleration going into the end of the quarter? I would hope so.
We saw strong performance in March, strong performance in June, and if that can repeat, we'll see where we land. But that's kind of the lay of the land and what things are looking like at the moment. And of course, we'll update, as I mentioned earlier, with the final July and then the mid quarter update with our August trends.
Headcount
ODFL has invested ahead of their growth curve in personnel as well. They will be in a position to not just be reactive when volumes finally do pick up.
Well, I think we're in a good spot from an overall headcount standpoint. At the end of June, we're 150 to 200 people ahead of where we were in September of last year when we were handling 51,000 shipments per day, so we're in a good spot there. It drifted down just normal attrition kind of taking place through the second quarter. And if that continues to occur as we go through the second half of the year, we're always balancing the changes and so forth, generally in alignment with what our shipment counts are and how they're changing.
So it'd be something that we continue to watch and deal with. But at this point we're getting closer to where you generally have the seasonally slower parts of the year once we get into 4Q and 1Q, but we're keeping our eye out for what 2025 might look like and you don't wait until it's coming at you.
You've got to get ahead of the curve, if you will and that's why this year we invested so much, and we always are investing in our people and restarted our truck driving schools and so forth and it continued to increase the number of employees with their CDLs to be ready for when our customers call on us and they need capacity, we want to be in a position to be able to respond with a yes, we can help you versus trying to play catch-up and be reactive.
Wages Impact on Cost per Shipment
Nothing major to note on wage impact for the cost per shipment, managements goal is to offset this through their yield management philosophy.
When you look over the longer term, when you look at our cost per shipment, if you will, wage cost per shipment, it's generally going up about 3% to 3.5% and more in line with what the wage increase that we give every year has been. There's been inflation that we've seen in our benefit cost, and we experienced some of that as well in the second quarter. And those fringe benefit costs include multiple factors, some of which are improvements to the overall comp program that we offer to employees and things like paid time off benefits that we've improved over the years and the quality of our group health and dental programs as well.
So, I mean, those are incremental changes that we're always having to manage. And maybe there's a little bit more variability in terms of when you're self-insured on the health program, you can have changes in one quarter versus the next that aren’t necessarily going in alignment with what shipment volumes may be changing. But looking over time, that's just something that we would expect will continue to change and reflect the improvements. In terms of the benefit program and comp program that we offer employees. But 65% of our costs are salaries, wages and benefits, so that's generally been the biggest driver of our total cost for shipment inflation. That's averaged 3.5% to 4% over the long-term as well, so that all goes into it.
We've had a lot of other incremental inflationary items, things like the cost of our equipment, maintenance costs that have been up double digits on a per mile basis the last few years, insurance costs that is a problem for the industry, that have been up double digits for multiple years in a row. All of those things we contend with and that's why there's got to be an ongoing focus on operating efficiency and discretionary spending, and we're managing our costs day by day in good times and bad.
If you wait until it's too late, if you wait until they're bad times, you got to have that focus going every day or you may not even know where to start. So that's something that we're always looking at. How can we offset all those other costs to basically keep our cost inflation in check and then, as you know, the yield management philosophy is we try to achieve 100 to 150 basis points of positive spread over top of that cost inflation metric. So that keeps our pricing levels in check with the rest of the industry as well. So it all kind of goes into it, but it's a day by day fight to try to keep our cost inflation minimized as best as we can.
Market Tonnage per day Growth & Overheads Costs
Management confirmed 10 basis point change from Q2 to Q3 as an average over 10 years.
ODFL has some tonnage ground to make up, probably won’t get fully back on track until 2025.
Overhead costs have gone from 17% of revenue to 20-21% of revenue.
55,000 - 60,000 per day is where management thinks the operating density in their model will be able to show it’s true strength.
Let me just address the second quarter to third quarter change. You're right, the pure math is more about a 10 basis point change, but there are a couple of years in there that skew that. In 2023 last year obviously we had a major acceleration in revenue that allowed us to improve the operating ratio 170 basis points from 2Q to 3Q and then 2020 was similar where you had the COVID cliff that happened and then the reacceleration of business levels. So when I just look at more of a normalized kind of progression, that's typically what we'd expect, unless you've got something unusual going on that would drive some change there.
With respect to the tonnage question and shipments, obviously as you said, we had the acceleration that was meaningfully happening last year. If you recall, we were at 47,000 shipments per day, really from December of 2022 through July of 2023, and immediately stepped up to about 50,000 in August and then accelerated further to 51,000 in September. So, step function change that would be well above anything that was really happening with the underlying economy, if you will. So, if we can see some type of normal acceleration, if you will, just like from a tonnage standpoint, our 10-year average from July to August is six tenths of a percent increase there and then about a 3.5% increase in September. So we'll see how that goes.
But right now, even if we hit those, it would look like you would have a negative change in those volumes. But overall, I think it's just as we look at things sequentially, maybe more so than just a year-over-year, given that challenge is what can we achieve relative to what normal seasonality would be and what we've seen at least so far through July. From a tons per day standpoint, just from a pure quarter, we're typically up about 1% when we gave the numbers earlier, but in the second quarter, that average is just call it 6% and we were up 3% just sort of rounding numbers. So we were up kind of half of what normal seasonality would suggest.
So we've got to make up some ground. Like I said earlier, we always lose a little bit of business in July, and that's normal. And so if we can have kind of a little bit of acceleration through August and then see some acceleration into September, we were almost at normal seasonality in the June period. And the same thing with March, you've got to adjust for the Good Friday, but we're about at seasonality in those stronger growth months of the quarter.
So if we can make some progress in August and then see some sense of that strong acceleration through the month of September, I think we'll be okay. And we've position ourselves well, whenever we come out of this true economic downturn, where we're operating at a 72, essentially, and 71.9. I guess I should take credit for every basis point we have in terms of where we've operated. And when I look at the breakdown of our operating ratio in the quarter and where we are from an overhead standpoint relative to our direct variable costs, I'm really pleased with the improvement that we've made with our direct cost performance. And that just gets into the day-to-day management within our operations in the field, primarily.
But everyone is contributing to that overall operating ratio. But our overhead costs have increased. They were 20% to 21% of revenue in the most recent quarter. Those costs have been down to around 17% in the past. So once we get some true density coming back into the network, we've built our network and our system to accommodate more than 50,000 shipments a day. So once we get back into 50,000, 55,000, 60,000, whatever that number is, that's where you'll really see the power of operating density in the model.
And you move that scale from 20% to 21% back towards 17% that puts us back in with an overall with the 6 handle on it, back where we were in 2022. So I think we're in a great spot and have managed through this downturn very well and has certainly put ourselves in a great position to capitalize on the market when we actually start seeing some economic wins at our back.
Customer Sentiment & Extra Capacity Coming Online
Top 50 customers are up mid-single digits.
ODFL is not seeing impact from additional capacity coming online from the Yellow Bankruptcy situation.
Still 130 service centres from them that are unsold.
Good morning, this is Marty. I'm going to answer your customer question. I'm still heavily involved with a lot of our top customers and the feeling out there is not all doom and gloom. In fact, our top 50 customers are up mid-single digits year-to-date. So we're getting a lot of positive remarks, especially from our larger customers and they as well see some positive things for the rest of the year. So we're very positive of and that those things will continue. And as Adam said earlier, they feel, and I feel if we can see some interest rate drops toward the end of the year, I think we'll really accelerate. So we're looking forward to that and prepared to handle it. So it's not all doom and gloom out there, trust me.
Yes. And on the competitive side, we've not seen, I don't think, any material change in the sense of, if someone has opened one service center in whatever market, any type of real impact. And as you can see in our yield trends, things continue to be consistent with our performance. That's just something we'll continue to manage through and monitor. But given the cost that went into purchasing many of these facilities, we'd be a little surprised to see someone going out and having to be aggressive to try to fill it up. And at the end of the day, those service centers served the market for a reason. They were in existence. And those particular markets had a customer base that their sales rep called on and there are LTL shipments that are out there.
And as I referenced earlier, I mean, the market is down overall and we estimate that it's down about 15% from back from in 2021, but that's something that will recover. Those LTL shipments, those customers will continue to have freight that needs to be moved through an LTL network. And I think that will end up creating opportunity for us, for the industry in general, to refill those facilities, if you will, once they come online. But to me, it creates maybe even more of an opportunity for Old Dominion specifically.
There are still over 130 facilities that haven't been sold from the Yellow (YRC) Bankruptcy. So that's actually less capacity when things pick up than we had when YRC was still in business.
New Service Center Openings
Three new service centres opening in 2024
CapEx plans haven’t changed from guidance.
Management plans to finish construction of these three facilities, and will record the depreciation on the income statement even if demand doesn’t come back fully in the short-term. Once it does, then incremental overhead costs will be incurred to meet the demand.
We've opened three service centers this year and we're continuing to execute on our CapEx plan. The current estimate is to spend about $350 million this year, at least on the real estate component of that program. So our plan is we look at the network. We look at the service centers that we feel like need some measure of capacity. And when we look kind of over the next five years, and what the anticipated growth curve may be and the efficiency of the network comes into play as well, the location of where these facilities are and so that kind of goes into the overall plan.
And we're a little bit heavy right now, frankly. It's not unusual when we go through a slower economic environment to get a little ahead of the curve. Our long-term strategy is we like having 20% to 25% excess capacity in the system. We're at about 30% today and that's okay. We're comfortable with that. Now, what that may mean is exactly what you said. There may be facilities that are in process today.
We will finish those facilities, and if the demand environment doesn't dictate that we go ahead and open them immediately, we'll finish the construction, we'll start the depreciation and so forth of those facilities. But we'll wait until there's stronger demand to really justify the opening and all the incremental overhead cost that goes along with those facilities once they're operational.
ot just the overhead, but there's configurations to the line haul network that has to happen, and generally that negatively impacts load factors. So that's something that these other carriers that are opening multiple facilities will be facing the incremental cost there, which is another reason why we don't anticipate seeing reductions in pricing or any pressures there.
But so that's something that just goes into it and we'll continue to look and evaluate, but overall continuing to plan and we'll continue to -- the investments that we make are really just based on what we think the market share opportunities are in each of the respective areas. And so we feel like we've got tremendous opportunity ahead and thus we intend to continue to spend 10% to 15% of our revenue revenues every year on total capital expenditures, the real estate, and then obviously on the fleet and the technology side as well to keep pace with our anticipated growth.
LTL Carrier Struggles vs Larger Peers?
ATA/LTL tonnage index, it's down about 8%. And a year ago, before Yellow, the volumes of the publicly traded LTL carriers were tracking more closely to that. Since Yellow happened, the publicly traded group is showing kind of flat to up 2% tonnage, but the ATA tonnage index is still showing down about 8%. Why would it diverge so much?
Full truckload carriers will most likely get stretched as the economy recovers and ODFL will benefit greatly from this.
Well, I think probably what you saw when YRC went out of business is that, customers were struggling to find ways to move that freight. And some of it went, and not a large portion of it, but some of it went to your smaller freight forwarders, airfreight forwarders, smaller logistic companies and I think that's where some of that has gone. And those guys basically don't have any assets, so they're handling it at a lower rate. And I think some of that business moved to full truckload carriers as the economy started to slow.
And as I've said before, when your economy starts to pick back up your -- the LTL industry will benefit from that, even from the full truckload industry because we saw some of that freight move to those full truckload carriers as it relates to stop offs. And once those full truckload carriers begin to get busier and their capacity gets tighter, that freight will move back toward the LTL industry. So I think that type, the business moved a little bit everywhere based on price and so that's how I see it. That's the only way I can explain it.
what a nice write up. Just wondering if you anytime analyzed TFI International as well? I like the acquisiton strategy. What about you?